As we begin the new decade, the outlook for savers remains quite dire. Currently, the top easy-access cash ISA rate is just 1.35%, which is lower than the rate of inflation.
That said, if you’re willing to take on a little risk, there are ways to generate a much higher return on your money. Here, I’ll explain how it’s possible to generate a yield of 5% and higher, tax-free, on your money, by investing in dividend-paying companies within a Stocks and Shares ISA.
Boost your wealth with dividends
Dividends are cash payments that companies pay to their shareholders on a regular basis, out of profits. Not all pay dividends (high-growth companies often prefer to reinvest their profits). But here in the UK, plenty do.
For example, well-known FTSE 100 companies such as Royal Dutch Shell, Lloyds Banking Group, Legal & General Group, and GlaxoSmithKline, all pay their shareholders dividends on a regular basis.
You’d be surprised just how generous many UK companies are when it comes to rewarding their shareholders with dividends. Compared to Cash ISA and savings accounts interest rates, the dividend yields offered by many FTSE 100 companies are amazing.
For example, Shell paid its shareholders dividends of $1.88 per share last year which, at the current share price and exchange rate, equates to a yield of 6.4% – nearly five times the top Cash ISA rate. Similarly, Legal & General paid out 16.4p per share in dividends, which equates to a yield of 5.3% at the current share price (analysts expect a higher payout of 17.5p per share for the year that just passed). Meanwhile, Lloyds currently has a yield of 5% and GlaxoSmithKline yields 4.5%.
There are plenty of FTSE 100 stocks that have higher dividend yields too – for example, Aviva currently yields 7.1%, while tobacco giant Imperial Brands yields a colossal 11%.
But if we keep things simple for now and just consider Shell, Lloyds, Legal & General and Glaxo (which I view as four pretty solid dividend stocks), you’re looking at an average dividend yield of around 5.3% – nearly four times the top Cash ISA rate.
Split £10,000 across these four stocks, in a Stocks and Shares ISA, and you’re looking at dividends of more than £500 per year, tax-free. When you consider that £10K in the top Cash ISA is only going to pay you £135 for the year, £500+ in income from dividend stocks is a pretty good deal, in my view.
Risks to consider
Of course, there are risks to be aware of. For starters, when you invest in shares, your capital is at risk. Share prices move up and down, meaning you might not get back what you invested.
Each company has its own unique risks to consider. Given the volatility of stocks, it’s generally recommended you invest in shares for at least five years. Secondly, dividends are not guaranteed. If a company’s profits fall, the dividend can be reduced, or even cut.
However, when you consider the kind of income stream you could potentially build from a diversified portfolio of dividend stocks, the risks of investing in dividend stocks are very much worth it, in my view.
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Edward Sheldon owns shares in Royal Dutch Shell, Legal & General Group, GlaxoSmithKline, Lloyds Bank, Aviva, and Imperial Brands. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended Imperial Brands and Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.